Olympics and stocks don't mix

Commentary: Sports can lead investors into acting irrationally

ANNANDALE, Va. (MarketWatch) -- I have some important investment advice for you in the event your favorite athlete or team loses in the Olympics:

Take a break.

Don't even consider making changes to your portfolio for at least a day or two.

Why?

Because, if you're like most investors, you are prone to act irrationally when your favorite sports team loses.

I arrived at this conclusion not by watching sports enthusiasts at the local bar. Instead, it was reached by a rigorous academic study that appeared in the August 2007 issue of the prestigious Journal of Finance. The study, "Sports Sentiment and Stock Returns," was conducted by Alex Edmans, an assistant professor of finance at the Wharton School of the University of Pennsylvania; Diego Garcia, an assistant professor of finance at the University of North Carolina (Chapel Hill); and Oyvind Norli, an associate professor of financial economics at the Norwegian School of Management.

To isolate the role that mood plays in investing, the researchers analyzed the returns of a given country's stock markets immediately following losses of its national teams in international competition. They focused primarily on soccer matches in the World Cup, but they also studied cricket, rugby and basketball matches as well.

The researchers found, on average, that if a country's team loses in the World Cup elimination stage, its stock market the next day produces a return that is 38 basis points lower than normal. To be sure, 38 basis points might not seem that big of a deal, but from a statistical point of view it is huge. It is equivalent to an annualized loss of more than 60%.

The researchers could find no rational explanation for these lower returns. They therefore concluded that those diminished returns were caused by the "impact of sports results on investor mood."

To be sure, there is no direct or easy way of exploiting the study's findings to devise a trading strategy. But that's not the point.

Instead, the reason to bring this study up in the context of the Olympics is to remind us how much our psychology and mood can affect our investment decisions. And, needless to say, our moods are affected by a lot more than what's happening in the sports arena.

In my experience, few investors even recognize the role that their emotions play in their decision-making. When challenged, they are able to point to a litany of reasons, all well documented, for why their strategy is strongly based on a sound statistical foundation. But, most of the time, I still don't believe them.

That's because there are different types of reasons. On the one hand, there are the reasons that genuinely account for why we have decided to do something. And, on the other hand, there are the reasons that we turn to, after a decision has been made, to justify it to ourselves and others. Most of the investment reasons that I hear or read about are of the latter variety.

I am particularly attuned to this distinction between different types of reasons because I read the daily communications from nearly 200 newsletters. I can assure you that, at any given time, there is no shortage of reasons that can be marshaled for doing just about anything in the market.

For example, if I want to be bullish on the stock market right now, I can give you a long list of "good" reasons to be bullish. Yet, at the same time, I can give you an equally long list of equally good reasons to be bearish. The same has been continuously true since 1980, 28 years ago, when I began monitoring the newsletter industry.

In the face of these myriad conflicting reasons, it's all too easy to make decisions for reasons other than the ones we tell ourselves and others. It reminds me of a famous saying attributed to Adlai Stevenson, the Democratic candidate for president in the 1952 and 1956 elections. Mocking his political opponents, he would say: "Here is the conclusion on which I base my facts."

It would be one thing if investors were cynically engaged in this practice of fooling themselves. But my wife, a clinical psychologist, assures me that most of the genuine reasons for our behavior are unconscious to us -- like dumping our holdings following the loss of our favorite sports team.

You might think that the answer to all this is just to throw up your hands. But it isn't. The far better solution, in my opinion, is to pick a mechanical strategy and then adhere to it with discipline and patience. That way you are prevented from doing something for emotional reasons.

If you take this investment lesson to heart, then maybe watching the Olympics will end up making us better investors after all.

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